Directors’ Liability for Payments After the Company Becomes Insolvent

The German Federal Court of Justice (Bundesgerichtshof – “BGH”) has recently clarified a long disputed question and increased legal certainty for directors who want to maintain business operations after a company becomes insolvent and are obliged to make payments to this end. If the insolvent company receives counter-performance in direct economic connection with the payment, then the director shall be exempt from liability for the outflow of assets, provided that the counter-performance is able to maintain its value at the time of its inflow.

Payments and the impairment of assets are prohibited for corporations and GmbH & Co. KG companies after they become insolvent. Breaches thereof will result in personal liability of the management. Limited Liability Companies (Gesellschaft mit beschränkter Haftung – “GmbH”) are regulated by section 64 of the German Limited Liability Companies Act (GmbH-Gesetz – “GmbHG”); GmbH & Co. KG companies are regulated by sections 130a, 177a of the German Commercial Code (Handelsgesetzbuch – “HGB”); and stock corporations are regulated by sections 92 (2), 93 (3) no. 6 of the German Stock Corporation Act (Aktiengesetz – “AktG”). The purpose of these regulations is to preserve the company's assets for the future distribution of assets to creditors in insolvency proceedings. Therefore, liability under those provisions will only be considered to the extent that the disposal of assets has not been offset by counter-performance. The majority opinion in legal literature and existing case law has only recognized such compensation as exempting liability, if the compensation was still part of the bankruptcy estate at the time that insolvency proceedings began - a theoretical case that never occurred. Prior to its judgment of 18 November 2014 (case II ZR 231/13) the BGH also held that compensation should not only flow into the company's assets, but also remain there. This interpretation has now been expressly renounced by the BGH in its judgment of 18 November 2014. The decisive factor is the point in time when the counter-performance flows into the company.

The judgment creates more clarity and is welcomed in general, as it will facilitate the recovery of companies, by giving them at least a small possibility to continue business operations after becoming insolvent. The continuation of business operations usually improves a company's chances of staying in business and recovering from bankruptcy proceedings and is therefore ultimately in the interest of creditors. Because the direct exchange of performance and equal counter-performance also satisfies the requirements of so-called cash transactions (Bargeschäft) pursuant to section 142 of the German Insolvency Act (Insolvenzordnung – “InsO”) and the performance of the debtor to the business partner generally does not fall under the insolvency proceedings, it is very likely that crisis managers and their business partners will have a similar interest in such an exchange and counter-exchange of performance.

However, the decision does not affect the statutory obligation to file for insolvency when the threshold for insolvency is reached, whereby the application for insolvency must be filed at the latest within three weeks. During these three weeks, directors are now able to arrange for payments without liability, provided that there is an equal counter-performance. For longer periods, the risk of liability will occur due to the remaining ambiguity about rental payments and other types of counter-performance.

In procedural terms, it will be interesting to see whether the liability of directors due to failure to file for insolvency in due time pursuant to section 64 GmbHG - which has recently been less relevant - will now gain greater significance pursuant to sections 823 (2) of the German Civil Code (Bürgerliches Gesetzbuch – “BGB”) in conjunction with 15a InsO.